Eight years and 29 drafts later, the American Law Institute (ALI) voted on May 22, to approve its “Restatement of the Law-Liability Insurance” (Restatement or RLLI). The final version has 50 sections and is almost 500 pages long. The project has been heavily criticized along the way, with lawmakers, insurers, policyholders and regulators, among others, all voicing concerns, including that it reflects the reporters’ aspirational views of what the law should be. This criticism is hardly surprising given that “Restatements are primarily addressed to courts” and meant to “reflect the law as it presently stands or might appropriately be stated by a court.”
Now that the Restatement has been approved, the debate has shifted to the role that it may play in courts’ future decision-making as a nonbinding document. Here, we highlight several potentially troublesome provisions for insurers relating to the defense and settlement of claims and “bad faith,” and consider the Restatement’s potential impact going forward.
Restatement Section 15 provides that “an insurer may reserve the right to contest coverage for an action before undertaking the defense of the action if it gives timely notice to the insured of any ground for contesting coverage of which it knows or should know,” see RLLI §15(1) (Am. Law. Inst. 2018). Of greater concern to insurers, Section 15 also requires insurers to update reservations of rights within a reasonable time after learning of facts that provide another basis to contest coverage or risk losing that potential defense. As a practical matter, this increased burden could distract insurers from focusing on their policyholders’ defense by forcing them to spend time scrutinizing each piece of information (pleading, testimony, etc.) they receive to determine whether it contains other potential grounds to disclaim coverage. Costly, time-consuming disputes concerning the facts which were known (or should have been known) by an insurer and when the insurer learned of them can also be expected.
Insurer Liability for Conduct of Defense
Restatement Section 12 contemplates that insurers may be liable for harm caused by the malpractice of their appointed underlying defense counsel based on “negligent selection” (where counsel does not have “adequate skill and experience in relation to the claim in question” or “adequate professional liability insurance”); or where the insurer overrides counsel’s independent professional judgment and causes a breach of professional standards of care, see RLLI §12 cmts. b-d. Even the ALI acknowledges the “dearth” of support in reported cases for holding insurers directly or vicariously liable. Indeed, except for a few jurisdictions that have adopted a version of vicarious insurer liability (which the Restatement rejects), “very few cases can be found even hinting at insurer liability for the misconduct of counsel retained on behalf of an insured.”
Several sections of the Restatement address underlying claim settlements. For example, Section 24 imposes a broad duty on insurers to make “reasonable settlement decisions” when the potential exists for an excess judgment. Section 25 adds that a reservation of rights does not relieve the insurer of that obligation and, subject to certain procedural requirements, authorizes an insured in that situation to settle a claim without the insurer’s consent. The comments suggest this is a modified version of what is “perhaps not yet the majority rule.” They warn of the rule’s potential for collusion as well.
Under Section 27, an insurer that breaches the duty may be liable for any resulting foreseeable harm, including an excess judgment against the insured. If an unreasonable failure to settle also results in a punitive damages award, Section 27 would require the insurer to indemnify its insured for the award even if punitive damages are excluded from coverage or are uninsurable as a matter of public policy. As the ALI acknowledges, this rule is based on two dissenting opinions and a legal malpractice case from 1990.
What’s more, the Restatement’s confidentiality rules may actually stymie insurer settlement efforts. Section 11 provides that “an insurer does not have the right to receive any information of the insured that is protected by attorney-client privilege, work-product immunity, or a defense lawyer’s duty of confidentiality under the rules of professional conduct, if that information could be used to benefit the insurer at the expense of the insured.” According to Comment d, an insurer’s “right to defend does not include the right to receive confidential information from the defense lawyer that could harm the insured with regard to a matter that is in dispute, or potentially in dispute, between the insurer and insured.” What “could harm the insured” and what is “potentially in dispute” is subject to interpretation. Insurers may thus find defense counsel less willing to be forthcoming. The potential chilling effect on communications creates tension with the recognized need to share information for an “effective defense” (see Comments a-b) and may ultimately impede the ability of insurers to make timely, appropriately informed settlement decisions.
Recoupment of Defense and Indemnity Costs
Restatement Section 21 adopts a default rule that an insurer cannot recover its defense costs following a determination of no duty to defend, unless the insurance policy authorizes it or the insured agrees. A unilateral statement in a reservation of rights letter alone is, therefore, not enough to create a right of reimbursement. The rule purports to derive from an “emerging state-court majority rule,” but the comments acknowledge that “about half of the state courts that have considered this issue, and a majority of the federal courts making Erie predictions, have held to the contrary, based on a theory of unjust enrichment.” A similar rule applies to settlement payments.
Section 49 of the Restatement provides that an insurer can be liable for bad faith when it fails to perform under a liability policy “without a reasonable basis for its conduct;” and “with knowledge of its obligation to perform or in reckless disregard of whether it had an obligation to perform.” This section combines both objective and subjective elements. Thus, “an insurance company is not acting in bad faith when it employs a rigorous claims-handling process, but only when its actions evince a conscious or reckless disregard of a policyholder’s rights and a deliberate choice to promote the insurance company’s interests at the policyholder’s expense.”
Under Section 50, remedies for “bad faith” include compensatory damages, punitive damages if available under applicable state law, and “other remedies as justice requires.” Comment c notes that while the remedies are generally limited to damages, an insurer may also be estopped from asserting coverage defenses in some circumstances. It adds that this is “particularly appropriate when an insurer refuses to defend in bad faith.” This forfeiture penalty draws from a minority position on breaches of the duty to defend generally and, in the case of a bad faith breach, a rule that “unequivocally applies only in Washington.”
The Restatement has rightfully been the subject of disagreement for the insurance industry for some time now, and the controversy over its shortcomings has only continued since its approval. Shortly after adoption, the President of the National Council of Insurance Legislators (NCOIL) admonished that “judges around the country should recognize this Restatement is as much a drafters’ wish list as an authoritative reference regarding established rules and principles of liability insurance law.” He promised that NCOIL will “examine all necessary steps to rectify this overreach, including the necessity for a model law that accurately states what the law is on certain liability insurance law topics.” NCOIL Statement on ALI ‘Restatement’ of Liability Insurance Law (May 25, 2018).
So far, at least two state legislatures have rebuked the Restatement. Earlier this year, Kentucky’s House of Representatives “urged that, if meaningful change to the proposed Restatement does not occur prior to its final approval, the Restatement of the Law of Liability Insurance should not be afforded recognition by courts as an authoritative reference regarding established rules and principles of insurance law, as Restatements have traditionally been afforded.” The resolution passed 90-0. Similarly, on July 30, 2018, Ohio Gov. John Kasich signed into law S.B. 239, which declares that the Restatement “does not constitute the public policy of this state and is not an appropriate subject of notice.”
As of this writing, fewer than 10 known cases have cited to the Restatement or its drafts. Most have done so merely as additional support for existing law, where there was no available authority, or for general principles of insurance law, e.g., Mid-Continent Casualty v. Petroleum Solutions, 2016 U.S. Dist. LEXIS 182174, at *11 & n.28 (S.D. Tex. Dec. 16, 2016) (test for breach of duty to cooperate); Nooter v. Allianz Underwriters Insurance., 536 S.W.3d 251, 271-72 (Mo. Ct. App. 2017) (discussing pairing of allocation and exhaustion methodologies); West Hills Development v. Chartis Claims, 385 P.3d 1053, 1055 (Or. 2016) (citing Section 13 for duty to defend “four corners” rule); Selective Insurance Co. of America v. Smiley Body Shop, 2017 U.S. Dist. LEXIS 215904, at *14-16 (S.D. Ind. July 28, 2017) (citing to Section 21 and decisions from other jurisdictions, given no reported Indiana law on recoupment of defense costs). Already, at least two courts have declined to follow the Restatement given existing law. Catlin Specialty Insurance v. CBL & Associates Props., Inc., 2018 Del. Super. LEXIS 342, at *8 (Del. Super. Ct. Aug. 9, 2018) (allowing reimbursement of defense costs under Tennessee law, noting that “Restatements are mere persuasive authority until adopted by a court; they never, by mere issuance, override controlling case law”); Catlin Specialty Insurance v. J.J. White, 2018 U.S. Dist. LEXIS 31189, at *39 (E.D. Pa. Feb. 26, 2018) (addressing loss of coverage defenses for breach of duty to defend).
These early indications suggest that the Restatement is unlikely to fundamentally alter the legal landscape for liability insurers or their policyholders. In the end, the impact of what has been eight years in the making may not be nearly as great as anticipated.
Gregory LoCasale is a partner at White and Williams and co-chair of the firm’s Insurance coverage and bad faith practice group. Contact him at firstname.lastname@example.org.
John Anooshian is a partner with the firm. He represents insurers in insurance coverage litigation, bad faith and other disputes. Contact him at email@example.com.